[2023 Bond Outlook] Interest Rate Hikes in the Second Half... Buying Long-Term Bonds Pays Off

US Inflation Enters Slowdown Phase
Entering Late Stage of Next Year's Rate Hikes
CP Rates Decline Will Take Time

Investor Sentiment Improving Around High-Grade Bonds
SKT 10-Year Bond Offering Sees Excess Demand

[Asia Economy Reporter Minji Lee] Next year, the bond market is expected to see a decline in bond yields as the base interest rate hike trend eases and investor sentiment improves. However, corporate commercial paper (CP) and corporate bonds are predicted to experience a delayed improvement in investor sentiment, mainly for high-grade ratings. Experts advise continuing bond investments focused on long-term bonds.

◆ Suitable for Long-Term Bond Investment = According to the financial investment industry on the 9th, domestic bond market experts expect the Bank of Korea's final base interest rate level to be 3.5% or 3.75%. Those forecasting 3.5% anticipate that the rate hike cycle will end with a 25bp increase at the Monetary Policy Committee meeting in January next year, while those predicting 3.75% expect two hikes in January and March. The latter group analyzed that inflation, which has not yet fully stabilized, will be a variable. Commonly, they noted that U.S. inflation has entered a slowdown phase, marking the late stage of rate hikes, and that the growth forecast for next year has been revised downward from the 2% range to 1.7%, which will weigh on further rate hikes.

Experts advise that if considering bond investments, purchasing long-term bonds is appropriate. The Bank of Korea's expected neutral interest rate is around 2.5?3%, and considering concerns about an economic recession next year, long-term interest rates are expected to weaken and fall to the neutral rate level. Kim Ji-man, a researcher at Samsung Securities, explained, "When the Federal Reserve stopped the giant step (a 0.75 percentage point increase in the base rate) in 1994, long-term bond yields fell," adding, "The spread between domestic base rates, which have been excessively raised, and bond yields can gradually narrow as concerns about monetary policy ease, so attention to long-term bonds should increase."

◆ Slow Improvement in CP and Corporate Bond Investor Sentiment = It is expected to take more time for CP (corporate commercial paper) yields to show a sustained downward trend. Although the government launched a large-scale liquidity supply policy in October to stabilize the short-term funding market, CP yields recorded 5.54%, which remains high compared to two months ago (3.4%) and January (1.5%). The refinancing burden of project financing (PF) - asset-backed commercial paper (ABCP) that stimulated the rise in CP yields continues. Investors are cautious about the refinancing volume of securities company CP worth 15.7 trillion won and PF ABCP worth 17.2 trillion won, both nearing maturity, and are paying attention to year-end funding volatility.

The credit market is expected to see a gradual recovery. The timing is likely to be after the rate hike cycle ends and the government's policy effects (with a lag of 3?6 months) are reflected, probably in the second quarter. According to the Seoul bond market, as of the 7th, the credit spread (the difference between the 3-year corporate bond yield with a credit rating of 'AA-' and the 3-year government bond yield), which reflects institutional investors' sentiment toward corporate bonds, stood at 174 basis points. This is comparable to the level in April 2009 (171bp) during the global financial crisis. The highly stable 3-year government bond yield fell from the mid-4.5% range to the mid-3.6% range within about three months due to rate cut expectations, but the 3-year corporate bond yield remains around 5.4%?5.5%.

◆ Warmth for High-Grade Bonds and Continued Burden from KEPCO Bonds = At least, warmth is spreading for high-grade bonds. The day before, Hi Investment & Securities (AAA, guaranteed by DGB Financial Group) issued corporate bonds worth 300 billion won (1-year, 2-year, 3-year) after receiving 540 billion won in demand during the book-building process. On the 6th, SK Telecom (AAA) conducted a corporate bond demand forecast for 250 billion won and received orders exceeding 1.9 trillion won, more than eight times the amount offered. Even the long-term 10-year bonds (20 billion won) attracted 155 billion won. A bond management industry official said, "Investor sentiment is improving mainly for high-grade bonds due to the activation of the bond stabilization fund," adding, "However, it will take more time for investor sentiment to expand to perpetual bonds or lower-rated corporate bonds."

The supply burden of KEPCO bonds is expected to continue next year. This year, KEPCO issued bonds worth a total of 24 trillion won by the end of October to overcome deficits, and the large-scale supply of high-credit rating public bonds absorbed all market demand, imposing interest rate pressure on other corporate bonds. Lee Kyung-rok, a researcher at Shin Young Securities, said, "Even if companies convert loans through banks, this will soon lead to an expansion of bank bond issuance, so new liquidity must be supplied to meet the funding demand of KEPCO and the banking sector."